International Trade and Business Cycles

NBER Working Paper No. 5025Issued in February 1995NBER Program(s): IFMEFG

Virtually all economies experience recurrent fluctuations in economic activity that persist for periods of several quarters to several years. Further, there is a definite tendency for the business cycles of developed countries to move together--there is a world component to business cycles. This paper argues that capital accumulation and international capital flows are central to understanding world trade and business cycles. In particular, fluctuations in net exports and the current account are shown to be dominated by trade in capital goods. The paper develops a two country model of international trade within which capital accumulation and international investment flows play a central role. We explore the channels by which technology shocks and fiscal shocks are transmitted to the domestic and foreign economies, and discuss the extent to which these results are sensitive to individuals' opportunities for international trade in financial assets. Overall, we find that the models capture many of the salient features of international business cycles. However, it has proven consistently difficult to generate sufficient comovement across countries in labor input and investment. The paper concludes with a discussion of fruitful directions for future research.